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When Dixons Group chairman Sir Stanley Kalms talked to Marketing Week after Kenneth Clarke’s Budget he spoke in glowing terms (November 29). Ironically, every minute he was on the telephone the value of his company was dropping – in the end its value dropped 87m in the space of less than two hours.

Kalms was one of three things: badly briefed; so wealthy that the loss of 87m was seen as a drop in the Ocean; or – like everybody else in the electrical retailing, travel and motor breakdown industries – confused by a tax which could wipe out up to ten per cent of individual company profits.

Introduced as part of a wider clampdown on VAT avoidance, the new measure was a throwaway two sentences in the middle of Clarke’s cautious Budget. But it has left financial advisors in these sectors puzzling over the Chancellor’s decision to hike the tax on the insurance they sell with their products from 2.5 per cent to the full VAT of 17.5 per cent. If the rises are passed on to consumers it could add 20 to the price of electrical warranties, and about 5 to the bill for a two-week family holiday in the Mediterranean.

At the core of this confusion is why the Chancellor has gone down this route, risking possible high street price rises and the wrath of retailers already hit by the recession. The tax will raise an estimated 160m in its first year – a negligible amount.

The only conclusion is that it was intended to have an impact on the way electrical and travel warranties are sold. The Office of Fair Trading is reviewing a voluntary code drawn up by the electrical retailers last year after criticism of misleading sales techniques and somebody in the Treasury may have thought it was an opportunity to introduce a populist measure (MW July 26).

For companies like Dixons, the sale of extended warranties accounts for an estimated five per cent of profits. If they become more expensive and fewer are sold, it will directly hit the bottom line.

Analysts agree that the clause has been hastily drawn up. “This legislation seems to have been drawn up without much thought,” says NatWest Markets retail analyst John Richards. “The aim was, quite rightly, to close the tax loophole of value shifting in these sectors. But the result has been to create a new tax.”

The move was intended to affect companies who sell insurance as a package with their goods. TV hire companies, for instance, might rent a TV for 100 and arbitrarily charge 60 per cent as the rental and the remaining 40 as insurance. The insurance is currently taxed at just 2.5 per cent as opposed to 17.5 per cent for the rental. Industry observers claim this second figure is too high, arbitrary and an example of “value shifting”.

Analysts predict companies like Dixons and Comet will argue they are being unfairly hit by the legislation. Firstly, they will maintain that their insurance is sold separately from their products and not as a package.

They may also claim that the tax is not equitable. Insurers like Norwich Union will be able to sell insurance at four per cent tax, while Dixons will be forced to sell at 17.5 per cent. A spokesman for the Association of British Insurers admits: “This is unworkable. The result will totally distort the insurance market.”

Richards also points out that, if all the players pass on these rises, the tax will put inflationary pressures on the economy.

The development is of equal concern to the travel industry. Martin Brackenbury, president of the Federation of Tour Operators, expresses horror. “This will do great damage to our industry which is very price sensitive.” The travel sector is already claiming that the rise in airport taxes, also introduced in the Budget, will reduce holiday capacity by 1 million holidays in 1998.

However, this week retailers were still puzzled by what the Chancellor had said. There is confusion as to which retailers, and under which circumstances, the tax will apply.

Privately, companies admit that meetings with HM Customs &amp; Excise are being hastily arranged before Christmas to clarify how these proposals will apply. There is no appeal but there may be opportunities to include exemptions as the Finance Bill makes its way through Parliament next month.

This is how Clarke introduced the measure: “Customs will restrict access to special VAT schemes for retailers…I also propose to take steps against retailers who reduce their VAT bills when selling insurance with their products.”

On the evening of the Budget, Sir Stanley Kalms thought Clarke’s measures would not affect his group of stores. He told Marketing Week: “If the warranties are sold separately from the goods, VAT is not applied. This tax, as we understand it, does not apply to us. But if an extra tax is introduced, we will pass it on.”

By the following morning the official Dixons line had changed to the one taken by the other affected sectors. “At the moment it is all a bit sketchy,” says a spokeswoman. “We are awaiting further clarification on these proposals and will study them closely.”

Dixons’ share price dropped by 20p to 550.5p and owner of Comet and Woolworth’s Kingfisher saw its price fall by 13.5p to 624.5p. Analysts thought that this would affect Dixons overall yearly profits by as much as five per cent.

However, HM Customs &amp; Excise thinks the impending tax, which comes into force on April 1 next year, is anything but sketchy. A spokeswoman says: “Insurance premium tax will be taxable at 17.5 per cent if retailers sell insurance as part of a package, or customers are introduced to insurers through retailers.” At present, this would include virtually every player in this trio of sectors as they all have formal links with insurance companies.

But by the end of last week, the City seemed to be siding with the retailers. The Dixons share price had recovered to its pre-Budget value by Friday, as had those of the other electrical retailers.

One customs official claims that businesses in these sectors are guilty of “creative accounting” and value shifting to the insurance part of the transaction. “This was the sole reason for introducing this tax. And what this does is take away the temptation to treat accounts in this way,” he adds.

However, spokeswoman for the Association of British Travel Agents (ABTA) Jackie Gibson rejects this. She says: “I don’t think there is any more tax avoidance in this industry than in any other.”

And this seems to be borne out by the amount of revenue expected from the new tax – 160m in the year starting in April and 235m in the following year.

However, analysts think that the Treasury estimates are low, because the tax will include various types of insurance. “The amount collected from Dixons and Kingfisher stores could add up to 50m or 60m,” says one analyst.

“There are still some issues to be worked out,” says one travel industry insider. “We are in the period of horse trading now. It is pretty certain that these increases will come. But we will be looking to see how much scope for exemption there is in this tax. This lobbying will continue throughout the committee stage of the Finance Bill.”

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